Blame it on demonetisation or poor demand, bank loan growth fall to a whopping six-decade low of 5.08% in the financial year 2016-17, as against 10.7% a year ago, according to the Reserve Bank data, is a cause of concern.

As per the data, in the financial year ended on March 31, 2017, bank's outstanding credit stood at Rs 78.81 trillion compared to Rs 75.01 trillion as of April 1 2016.

Credit growth in financial year 2016-17 is the lowest since 1953-54 when it had inched up by a paltry 1.7%.

In January 2017, ICRA in its research report, had estimated India's credit growth in the range of 5 to 6% by the end of fiscal year 2016-17 (FY17) on account of muted credit demand and debt markets continuing to be favourite among loan buyers.

Corporate bond market

The central bank said that one of the main reason for this drop is rising corporate bond market from where companies are tapping funds even for working capital as most of them could have been turned away by banks due to their over-leveraged balance sheets.

Alok Shah, Banking Analyst, Centrum Broking, said, "One of the reasons for moderation in credit growth could be attributed to shift in credit demand towards non-bank channels like corporate bond and commercial papers.

On November 8, Prime Minister Narendra Modi had announced the ban on Rs 500 and Rs 1000 notes with immediate effect.

The government had given just 50 days to deposit the old currencies in bank accounts. This soared bank deposits.

According to a report by ICRA, which was released in January, said that the banks deposit growth on year-on-year (y-o-y) basis spiked from 11.3% on September 30 last year to 15.2% on December 23 last year before easing to 14.7% on January 6, 2017, on the back of the sharp uptick in deposits in the corresponding reporting fortnight of January 2016.

Dr VK Vijaykumar, Chief Investment Strategist, Geojit Financial Services, said, "Credit growth turned negative 2.3 % for the quarter ended December 2016 due to the impact of demonetisation. This had a pronounced effect on credit growth for FY2017 at below 5 %, which is a 60-year low."

"The primary reason for the poor credit growth is the poor investment demand in the economy. Investment demand collapsed from 34 % of GDP to less than 30 % of GDP. The poor investment demand, in turn, is due to the excess capacity in the economy."

Bad debts

The outlook on the asset quality of the banking sector seems to be weak even as the fresh non-performing asset (NPA) generation rate continues to show signs of moderation.

The annualised fresh NPA generation declined to 4.1% during the third quarter of 2016-17 compared to 10.7% during the fourth quarter of the financial year 2015 -16, 6.1% during the first quarter of 2016-17 and 5.8% in the second quarter of 2016-17, ICRA said.

Fresh NPA additions to gross NPAs during Q3 of fiscal 2017 inched down to Rs 26,400 crore compared to Rs 1,36,000 crore during the first nine months of the fiscal 2017, partly aided by higher write-offs during the last quarter.

Icra has projected gross NPAs to increase to Rs 7.5-7.7 lakh crore or 9.7-10% for March 2017 and Rs 8.2-8.5 lakh crore or 9.9-10.3% for fiscal 2018 with upside risks in case of slower resolution of SDR accounts, leading to higher slippages.

Kavita Chacko – Senior Economist, CARE Ratings, said, "The decline in credit growth is largely due to the banks unwilling and unable to lend to industry owing to their high bad debt, low demand for credit from industry who are faced with weak balance sheets and corporate’s viz. the larger and better rated ones, increasingly resorting to the bond markets for their funding requirements.

"Credit growth will come about when industry credit demand picks up as currently it is the retail segment that has been driving credit demand. The resolution of the bad debt of banks will also free up funds for lending."

But banks are cutting rates. Is it enough?

With the banks flooded with liquid cash soon after the demonetisation, they started passing on the benefits to customers by cutting the interest rates.

Even though banks recently announced rate cut in their lending rates, the rates offered by the debt capital markets remain lower than bank rates.

Bonds and Commercial Paper (CP) continue as important sources of funds for higher rated entities, as the flows into key investor segments such as mutual funds and insurance companies remain high.

Vijaykumar added, "Interest rate is only one of the factors determining credit demand. Even if credit is available at attractive rates, if demand for goods is deficient, businessmen will not borrow and invest. On the contrary, if demand is buoyant and capacity utilisation is at high levels, businessmen will borrow and invest even if interest rates are high.. This explains the present state of poor credit growth."

On the other side of the story, SBI managing director Rajnish Kumar told PTI that the decline suggests decoupling of credit growth and GDP.

"Earlier the math was very clear: if GDP grows at 7% credit growth should be at 14-15%. But now it seems a decoupling of the two has happened. There is no relationship between GDP and credit growth now," Kumar said.